Annuities can be a good retirement shelter; but shop carefully
Sometimes, trying to set a little something aside for retirement can turn up unpleasant surprises. Just over two years ago, a schoolteacher writes, she decided to open a flexible premium-deferred annuity, to enjoy the benefits of tax-free accumulation of interest and safety.
She already had a tax-sheltered group annuity with her school district but did not want to put all her retirement eggs in one basket. So she sent $2,891.61 to Bankers Life & Casualty Co. of Chicago to open the account. Since then she has made monthly payments adding up to $850, for a total $3,741.61 in deposits. Yet her last statement shows a balance of only $3,731.86, or $9.75 less than she's put in.
In this case, the annuity was sold with a 15 percent front-end ''load,'' or sales charge, something the salesman did not point out to her, although it was in the contract she signed. Thus, $433 was taken away from the initial investment before it could even start earning interest. It has taken two years of interest earned by the remaining money, plus the additional deposits, for the account to almost break even. And if she wants to get out and switch to another company, it will cost her nearly $200 in early-withdrawal penalties.
Since this person's account was opened, Bankers Life & Casualty (no relation to The Bankers Life of Des Moines) has dropped the front-end load from its annuity products. Now, 100 percent of the money begins earning interest as soon as the company receives it. At the time she started the annuity only a few companies had no front-end sales charge.
Today, however, a more financially aware public has forced insurance companies to be more competitive. Still, financial planners say, you need to shop around before starting an annuity.
(The flexible premium annuity is distinct from the single-premium version. A flexible annuity lets you start with a fairly small deposit and continue by adding small amounts, sometimes as low as $25. The single-premium version usually requires at least a $10,000 deposit. Future deposits must be made by opening new annuities, with the same minimum large deposits.)
There are some 900 insurance companies offering annuity products in the United States today, so reviewing them all is impossible. Yet the right questions, asked before signing the contract and the first check, can help.
* Is there a front-end sales charge? If so, how big is it? Besides Bankers Life & Casualty, several other companies, including Kemper of Chicago and Massachusetts Financial Services of Boston, have no front-end sales charge.
* Is there a penalty for early withdrawal? Most companies do have some penalty, yet they can vary widely. At one company, the penalty is 10 percent of the assets after the first year, 9 percent after the second year, and so on until the eleventh year, when there are no penalties. At another there is a 5 percent penalty in the first five years and no penalty after that.
At some companies, there is a fee for regular payments from the annuity at the end of the contract.
Of course, the Internal Revenue Service has its own penalty for early annuity withdrawls. Thanks to last year's tax act, there is 5 percent penalty on withdrawals not rolled over into another annuity or an individual retirement account. Also, the first money to be taken out of an annuity is considered taxable interest, rather than nontaxable principal. The idea is to make sure these products are used as retirement vehicles and not just as tax shelters, which many higher-income people were doing.
* What is the interest rate being paid on the policy? And, what is the company's past record in keeping up with current interest rates? Also, some companies will have an attractive rate they offer to new customers, but old customers are getting a lower rate. Avoid these companies. Most policies are paying 10 to 111/2 percent today.
You should also ask if the rate is a one-year rate or is guaranteed for a longer period, such as five years. At some firms that have a five-year guarantee , that is the rate through the whole term; at other firms, that is the minimum they will pay, and it could go higher if overall interest rates rise again.
* How strong is the company? ''The biggest thing today is quality,'' says William Freund, a financial planner at Prescott, Ball & Turben, a Cleveland brokerage. ''People used to think these things were as good as gold.'' But since the near-collapse of Baldwin United Corporation, a holding company that included a large insurance subsidiary, people are being more careful now. To help in this effort, Prescott and some other brokerages have built up their own rating departments to closely monitor companies and make recommendations.
* How is the policy being written? The most common way, says Jerome Alexander , a financial planner in Glencoe, Ill., is to make the annuity buyer the annuitant, or owner, and the person's wife or nearest relative the beneficiary. This is the wrong way to do it, he says. The right way is to list the buyer as the primary beneficiary, the wife as the secondary beneficiary, and the children as the annuitants. This way, if the buyer passes on, the wife gets the benefits at first, and after her death, the children, who avoid having to pay the deferred taxes on the lump sum. The couple's wills have to be carefully drawn to fit in with their plans for the annuity, he adds.
* How does the annuity fit in with your entire financial plan? Depending on how much you want to save, your education and retirement plans, and tax situation, an annuity may not be the best vehicle. An individual retirement account may suit you better.
With such a wide variety of annuities, concludes George Barbie, executive director of the Consumer Financial Insitute, a planning firm in Newton, Mass., consumers must remember ''that it's a buyer-beware situation. You have to shop these things very carefully.''
If you would like a question considered for publication in this column, please send it to Moneywise, The Christian Science Monitor, One Norway Street, Boston, Mass. 02115. No personal replies can be given by mail or phone. References to investments are not an endorsement or recommendation by this newspaper.